|
It is often assumed that the housing market is at the mercy of federal monetary policy. Observers note that home buying is largely driven by interest rates, with low rates encouraging buying and stimulating home prices and high rates discouraging buying and depressing home prices. This simplified framework, however, only captures half of the federal government’s role.
The federal government operates two punchbowls that serve to increase or decrease demand. While the monetary, or mortgage rate punchbowl, applies to all borrowers equally, the second, called the leverage or ease of credit punchbowl, largely applies only to entry-level buyers. Importantly, the recent spike and drop in mortgage rates, which first rose above 4.5% in August 2018, then almost reached 5% in November, before falling back to 3.7% today, offer a natural experiment to confirm the utility of the two punchbowl framework.
While the monetary punchbowl generally receives significant media attention, the leverage punchbowl and its focus on first-time buyers is often overlooked, yet it is no less important. As documented by the AEI’s Housing Center’s National Mortgage Risk Index (NMRI), which tracks underwriting standards for over 37 million loans since 2012, the first-time homebuyer NMRI is up 2.8 percentage points from February 2013, while the repeat buyer NMRI is flat. This divergent access to the leverage punchbowl has resulted in higher price growth of entry-level homes compared to move-up homes.
The impact of the varying availability of the two punchbowls can be demonstrated by examining various housing indicators. This analysis is helped by splitting the market into four leverage-based price tiers as the AEI Housing Center has done (see table). When mortgage rates started to rise, the move-up segment (medium-high and high price tiers with relatively lower levels of mortgage risk) was left without either punchbowl, while the entry-level segment (low and low-medium price tiers with higher levels of mortgage risk) still had access to the leverage punchbowl.
We first examine supply and demand conditions using the same four leverage-based price tiers. The best metric is months’ supply, which measures the speed it would take for the current level of inventory to sell at the current sales pace, all represented by a single number. Six months’ supply is generally considered the equilibrium point for the entire market when prices are stable. When months’ supply is increasing, prices tend to ease; when they are declining, prices tend to accelerate.
Monthly data from Zillow on listings and sales broken out by the same four price tiers confirm the importance of these punchbowls. Months’ inventory compared to a year ago began rising when mortgage rates had risen to about 4.5% in May 2018. This turn-around furthermore applied across all price tiers at the same time indicating the importance of the monetary punchbowl for all tiers. Yet, the rate of the rise was also related to the level of leverage as measured by the NMRI, indicating the importance of the leverage punchbowl for the entry-level. Absent access to this leverage punchbowl however, months’ supply increased faster for the upper two price tiers. It increased more slowly for the lower two tiers, which continued to have access to the leverage punchbowl (see chart). This trend continued until January, when mortgage rates had already started to decline from their highs. Subsequently, months’ supply increased less rapidly with the upper two price tiers exhibiting greater and faster swings.
These trends are largely born out in home price movements. While for the market as a whole, home price appreciation slowed from 5.6% in April 2018 to 3.7% in January 2019, there were large differences across the price tiers. Prices in the low price tier experienced a relatively minor dip over this period, but prices in the high price tier started to actually decline, a dramatic change from earlier robust price increases running about 4% year-over-year. Recently, as mortgage rates have retreated from their recent highs, home prices in the low tier are again picking up steam again, while they are still languishing in the high tier.
This episode epitomizes the conundrum of monetary policy for the housing market today. While lower rates may be required to keep the high priced end of the market stable, lower rates, combined with continuing first-time buyer access to leverage, only add fuel for home prices in the low tier to accelerate faster than market fundamentals would otherwise allow them to do.
We’ve already seen this phenomenon since home prices started to rebound in 2012. Since then, prices in the low price tier are up a cumulative 56 percent, while they are only up 17 percent in the high price tier. For the low tier, these gains have far outpaced gains in wages, which have only risen a cumulative 20 percent over the same period. With the Federal Reserve seemingly committed to holding rates down, this unsustainable trend will only accelerate until prices will eventually correct.
After connecting the dots regarding the two punchbowls, it is clear that a singular focus on just mortgage rates or the upper end of housing market can lead to faulty conclusions about the health and direction of the overall housing market.
It is clear that a singular focus on just mortgage rates or the upper end of the housing market can lead to faulty conclusions about the health and direction of the overall housing market.
|
|
